Economics

Taxation

You can't get something for nothing

AMERICANS, to a large extent, have only themselves to blame for the state of the economy. They consumed a lot that they did not want to or could not pay for. Cheap capital from abroad and easy mortgages fueled voracious consumption habits. Americans can blame China or Wall Street for offering loose credit in the first place. But in the end they, too, played a role. If anything undermines America's economic future, it is the belief that its residents are entitled to more than they can afford.

At least the financial crisis and great recession acted as a wake-up call. The American consumer needs to deleverage his personal balance sheet and the American government must formulate a medium and long-term plan to get its fiscal house in order. This means that Americans must start paying for what is consumed, not only by not running up huge personal debts but also by paying more taxes and receiving fewer entitlements from the government. This will not be easy; no one likes to pay more and get less.

On "60 Minutes" this week, Leslie Stahl pondered the so-called millionaire's tax—raising tax rates only on people who earn more than $200,000 a year. She went to Washington state where voters this week faced proposition 1098. It proposed an income tax (between 5% and 9%) on the top 3% of earners and a 20% reduction in property taxes for everyone. Currently Washington has no state income tax; the idea was to shift more of the burden to high earners.

Ms Stahl claimed the revenue will go toward an excellent cause: public schools. Yet unsurprisingly, many of the people subject to higher taxes did not support the proposition. She spoke to a few entrepreneurs. They suggested that higher taxes might change their behaviour or even provoke them to leave the state. A credible threat? There is not much evidence that work hours decrease with higher taxes (at least for men). The evidence is mixed about how much taxes encourage movement across states. Outgoing former New York Governor David Patterson, remarked on how high earners do leave the state when taxes increase. But generally, state taxes are only part of the equation for business owners, and housing costs and proximity to a viable labour pool are also important. Progressive taxation has many advantages; indeed the rich feel less pain from a higher tax rate than the poor and middle class. But it is also true that large jumps in the marginal tax rate have undesirable and distortionary effects—especially at the margin.

This is why consumption taxes make more sense. High marginal income taxes punish work and success. Why not tax consumption—something we are should be doing less of anyway? It is even possible to tax luxury goods at a higher rate, which makes consumption taxes more progressive. But alas, while there has been excellent commentary on instituting a VAT, no serious proposal has been considered by the government.

What really bothers me about calls to increase taxes on high earners only is that it sounds like voters (or the government) learned nothing from the past two years. When the government promises no cuts to services, state pensions or entitlements and that only high earners will pay for continuation of such services, it's a promise that Americans can have more while someone else picks up the tab. Washington's voters rejected the proposition this week (by a large margin), though that may reflect a general reluctance to have any sort of income tax in Washington rather than any pity for the wealthy. It's notable that Massachusetts voters rejected a proposition to lower their sales tax (they also chose to exempt alcohol from the tax).

Hiking income tax rates now is not a good idea considering the weak state of the economy. But in a few years everyone's taxes should increase, and not just those on the wealthy. This needs to happen for two reasons. One, America doesn't have enough high earners to pay for all the promises that have been made. Two, the sooner everyone accepts responsibility for debts the sooner everyone can move on toward future prosperity.

From the data I've seen, over the past 20 years top earners have increased their share of the pie, while the pie has not grown bigger. Seeing this "trickle up" occurring, is it not logical to then increase taxes to reverse the flow?

Or, since the SCOTUS considers corporations to have the rights of individuals, they too should bear the responsibilities. That's right, no more corporate welfare, tax breaks, and hiding wealth offshore. I wouldn't be surprised that if corporations paid the same nominal tax rates as traditional (human) American citizens, we'd cut that deficit down by hundreds of billions.

AMERICANS, to a large extent, have only themselves to blame for the state of the economy. They consumed a lot that they did not want to or could not pay for. Cheap capital from abroad and easy mortgages fueled veracious consumption habits. Americans can blame China or Wall Street for offering loose credit in the first place.

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But in a few years everyone’s taxes should increase, and not just those on the wealthy. This needs to happen for two reasons. One, America doesn't have enough high earners to pay for all the promises that have been made. Two, the sooner everyone accepts responsibility for debts the sooner everyone can move on toward future prosperity.

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The data directly contradicts A.S. The median workers, hell workers in the interquartile range, have had stagnant wages since like 1980. The big beneficiaries of the asset bubbles was the top 0.1%, with benefits as well to the rest of the top 1%, and 10%.

Additionally, the big debt bubbles were racked up by the "Greatest Generation" and the "Boomers", and young folks won't voluntarily agree to pay off these debts. They'll renege on the promises the Boomers and co made to themselves, by cutting benefits, devaluing the dollar, etc.

Further, the big banks lent a ton of money to consumers in an orgy of over-consumption, and then rammed through legislation in 2005 making the consumer bankruptcy laws much tougher on individuals. That's a change in expectations that the Economist claims not to like, but they were quiet as a mouse. Surprise, surprise, they're quiet when something helps the banks.

Further, the U.S.' massive trade deficit is the result of neo-liberal trade policies that encourage imports by the U.S. and allow protectionism by other countries. The neo-liberals always wanted free trade, but could never persuade other countries to go along, so they'd consistently negotiate deals with the US conceding a lot more trade barriers than other countries. Honestly, people like Laura Tyson would be happy as clams unilaterally repealing all US trade barriers, even if other countries repealed none. Naturally, if you do that, you'll wide up with global economic gains from free trade, but the US will lose out in aggregate benefits, and workers in the US will consistently lose out.

"High marginal income taxes punish work and success."
By and large, high earners are not paid by the hour. Much of their pay is bonus-based or through capital gains. There's little reason to believe that a corporate lawyer, tech entrepreneur or i-banker is going to decide to go home at 6pm instead of 10pm because his marginal tax rate on the portion of his income above $200,000 is 37% instead of 33%.

"Why not tax consumption—something we are should be doing less of anyway?"
Umm, last I checked, consumer demand is precisely what the economy needs, and the few folks making >$200k annually actually have the means to consume. Not to mention, a consumption tax on the average American making $35k annually (who probably is not required to pay income tax) would be incredibly regressive and damaging to consumer demand.

Lets not beat around the bush. I typically agree with this publication on most issues, but this column is using dogma as a cloak for greed and a myopic sense of entitlement.

To correct OneAegis, the pie has grown but the share of the top 20% has grown while the shares of all the other groups have shrunk. The growth in the top 20% has been concentrated in top 5% and that has been concentrated in the top 1% (and lately in the top .1%). I believe this is what is driving most of the political rage; people react to the changing circumstances and don't see a way out while they also see business as usual. So for example, the Democrats would have helped their cause immensely if they'd take the token effort in passing healthcare of including meaningful tort reform because that would say they were doing things differently and were willing to take on their own vested interests. I expect the voters want the GOP to take on its vested interests - and will be disappointed and full of rage when the GOP fails to do this.

The reason behind increasing inequality is the big question. My guess, since all we can do is guess, is that we're seeing segmentation of industry, with certain segments being exposed more and more to profit damaging competition while a few are reaping vast bounties, coupled with tax policy that has only exacerbated the problem. Our national response has been feeble. Compare Germany; they recognized that even with the lower cost East coming on board that they couldn't compete on cost with China, India et al so they made a conscious decision to focus on adding value. They are now the world's largest exporter. Much of our public policy debate is delusional because it acts as though we can somehow magically reduce costs - e.g., by eliminating unions and environmental regulations. That approach shows a complete ignorance of the cost levels in China, India et al, which would require reducing American standards of living manyfold, reducing most of us to poverty.

That said, taxing the better off is a sensible measure to reduce the fiscal deficit. It is not a long term solution to structural deficit problems. Obama has stated this clearly but people don't want to listen.

typingmonkey - Forget about corporations, if the ultra high earners actually paid the tax rates people think they do our financial mire would be far less dire.

I'm all for rebalancing our tax load toward consumption and away from earnings (perhaps with offsetting subsidies for folks in the lower half). But as important as reducing the penalty for wages (which should start firstly by reducing or eliminating payroll taxes) is cutting out the complex loopholes that make progressive taxation a fallacy in this country.

Our federal tax code should be about 60 pages at most, 10pt type: 20 for corporate taxes, 20 for individual income taxes, and 20 for consumption taxes (excluding tariffs, excise, regulatory fees and royalties). A constitutional amendment (coming from the people, not the legislature) enforcing such brevity is probably what it will take to get done, however.

Keep in mind that the Feds wanted exactly that type of behavior to happen. If the Fed reduces rates and no one borrows, what will the Fed do? It will continue to lower rates until a large number of people give in to the temptation to borrow whether they can afford it or not.

Also keep in mind the principle of marginal theory. The Fed doesn’t need every single person in the country to borrow; it merely needs a portion to do so. Most people in the US did not binge on credit. A percentage did. Most market transactions, particularly in housing, involve a very small portion of the total. For example, the vast majority of home owners did not sell or engage in house flipping. But prices are set at the margin, so the small number of people engaging in risky, high frequency trading determined the prices of housing for people who bough and held.

But if there weren’t a small number of “gamblers” in the country who will take risky bets on the Fed’s low interest rates, then Fed monetary policy simply wouldn’t work.

“There is not much evidence that work hours decrease with higher taxes…”

That’s true, but reducing work hours is not the only possible response to higher taxes for the wealthy. Most of the wealthy got their wealth from owning a business, so they can take out of the business less in terms of taxable income. Or they can invest in other businesses that have lost money and use that as a tax shelter. The wealthy have many ways to dodge taxes if they want. That’s why tax revenue declines after taxes reach a threshold.

“it's a promise that Americans can have more while someone else picks up the tab.”

Good point. “So long as it is legitimate for government to use force to effect redistribution of material benefits – and this is the heart of socialism – there can be no curb on the rapacious instincts of all groups who want more for themselves.” Hayek.

Also, keep in mind who does the investing in new and expanding businesses that provide jobs – the wealthy. What you take away in taxes you also take away from job creation through investment.

I agree we have ourselves to blame. The siren song of tax cuts is very beguiling, but without spending cuts the tax cuts are theft from the future. Will we cut spending? Doubtful. Republicans won't do it, and Democrats sure won't either.

I do appreciate the offer of a solution. It's become an accepted cowardice to state taxes ought to be cut and spending cut without offering means to cover debt or specifics about cuts.

But.... wouldn't a VAT decrease aggregate demand? We have the tail of the Tiger in our grip, and the Tiger's name is consumption. Our economy isn't going to take off as a result of household penny pinching.

If there's a tax that ought to be implemented it's the death tax. The dead are dead. Their progeny are either make something of themselves, or they don't. If exceptions need to be made then they ought to be based on the age of inheritors, and ill health. A healthy 30 year old ought to stand on his/her own merits. Aside from that, a death tax encourages spending during a person's life. Better for demand.

And the sooner everyone realizes that the debt is going to cost *them*, the sooner we can have a real conversation about cutting the size of the government. If I'm buying government with someone else's money, then I'm not worried about a big government. But if I'm buying government with *my* money, then I don't want to buy nearly as much of it...

Djryn, what difference does it make whether the dead guy spends the money he earnt during his lifetime, or if his progeny spend their inheritance after his death? It's not like that money disappears after his death. Not to mention that there may be a double taxation issue with a death tax.

Obviously, it is impossible to combine high marginal tax rates with economic growth, as the terrible stagnation of '50s and '60s America conclusively demonstrates.

Please - we're only considering going back to 2000 rates, and for people who are unlikely to decrease their consumption. Once confidence is restored, everyone else ought to join them. We were not overtaxed back when the expectation was that we'd pay off our entire debt before long.

jomiku, thank you for correcting me. As for venturing a guess as to the cause of rising inequality, I would point towards the huge increase in the financial institutions activity as a percent of GDP over the past 30 years as a major factor.

I have yet to see any modern example of a nation that was able to tax its way into economic prosperity. If it were that easy, wouldn't country after country simply jack up its taxes and sit back to watch its populace bask in newly created wealth?

Of course, we never see that happen, because we know it CAN'T happen -- confiscating wealth from the private sector to fill public coffers does not create economic growth, it retards it. A wise government taxes its people when times are good and peoples' bank accounts are flush, not when times are hard and folks are broke.

kamikaze80, I have no evidence that it makes a huge difference. It may not make any as I reckon the next generation may be well off enough to simply bank the money as well.

In any case I'm not sure that it the spending makes a difference, or is my best argument.

I'm just concerned that while I might stand to inherit more money, it's at the expense of also inheriting a very large deficit. I would prefer that my generation and my kids generation be in a position to inherit a vibrant economy unburdened by a large deficit. This seems like a reasonable way of addressing that.

CA_Observer, you're right, but there's the other narrative that easy credit helped keep wage demands in check allowing for lower inflation and greater compensation at the top. Maybe people do need to work harder, but productivity figures suggest that this wasn't the issue.

hedgefundguy, the majority of voters from 1980 through 2005 were boomers and older generations, so I blame them for the politicians racking up state and federal debt. And among politicians, the leadership is still mostly composed of boomers and up, and in business, the leadership is still mostly composed of boomers and up.

But blame whomever you like. Playing the blame game won't help you persuade the young to pay off entitlement programs, debt for bank bailouts, etc.

Yes, that the VAT would encourage savings at the expense of consumption is a good point, at least in the long run. It is also much more difficult to evade than income tax, especially for those not facing payroll reporting.